Topic 1

Introduction /
Choices and Trade-
offs
Course
Information
Please refer to MyUni for detailed course
information
Readings
▸ Chapter 1
Economics: Foundations and models
▸ Chapter 2
▹ Choices and trade-offs in the market

3
What is ‘economics’?

4
“ The study of choices people
and societies make to attain
their unlimited wants, given
their scarce resources
Hubbard, Garnett, Lewis, and O’Brien 'Essentials of
Economics’ 4th Edition, Pearson 2019
(Our textbook!)

5
Scarcity and trade-offs
▸ Scarcity: The situation in which unlimited wants exceed the limited
resources available to fulfil those wants.
▸ Resources: Inputs used to produce goods and services, including natural
resources such as land, water and minerals, labour, capital, and
entrepreneurial ability.
▸ Trade-off: The idea that, because of scarcity, producing more of one good
or service means producing less of another good or service.

6
Economics is used to answer questions
such as the following

▸ How are the prices of goods and services determined?

▸ How does pollution affect the economy, and how should government policy
deal with these effects?
▸ Why do firms engage in international trade, and how do government
policies affect international trade?
▸ Why does government control the prices of some goods and services, and
what are the effects of those controls?

7
Some key economic
choices
▸ What
▹ What goods and services will be produced?
▸ How
▹ How will the goods and services be produced?
▸ Who
▹ Who will receive the goods and services produced?

8
Markets
Market

A group of buyers and sellers of a good or service and the

institution or arrangement by which they come together to
trade.

9
Market Economy
An economy in which the
decisions of households and
firms interacting in markets
allocate economic resources.

10
Centrally planned economy An
economy in which the government
decides how economic resources
will be allocated.

11
Mixed Economy
▸ An economy in which most economic decisions
result from the interaction of buyers and sellers in
markets, but in which the government plays a
significant role in the allocation of resources.

12
Consumer Sovereignty
▸ A central feature of market economies is consumer sovereignty.
▸ Consumer sovereignty: The concept that in a market economy it is
ultimately consumers who decide what goods and services will be produced.
▸ This occurs because firms must produce goods and services that meet the
wants of consumers, or the firms will go out of business.

13
Efficiency
and Equity

14
Efficiency
▸ Productive efficiency: When a good or service is produced using the least
amount of resources.
▸ Allocative efficiency: When production reflects consumer preferences; in
particular, every good or service is produced up to the point where the last
unit provides a marginal benefit to consumers equal to the marginal cost of
producing it.
▸ Dynamic efficiency: Occurs when new technology and innovation are
adopted over time.
15
Equity
▸ “The fair distribution of economic benefits
between individuals and between societies.”

▸ But what is “fair”??

16
Microeconomics and
Macroeconomics

Microeconomics Macroeconomics

The study of how households and
firms make choices, how they
interact in markets, and how the
government attempts to influence
their choices.
The study of the economy as a whole,
including topics such as inflation,
unemployment, and economic growth.

17
Microeconomics and
Macroeconomics
Issues in microeconomics and macroeconomics
Examples of Microeconomic Issues
• How consumers react to changes in
product prices
• How firms decide what prices to charge
for the products they sell
• Which government policy would most
efficiently reduce obesity
• What the costs and benefits of approving
the sale of a new prescription drug are
• How to improve the labour market
outcomes of Indigenous youth
• What the most efficient way to reduce air
pollution is
Examples of Macroeconomic Issues
• Why economies experience periods of
contraction and increasing unemployment
• Why, over the long run, some economies
have grown much faster than others
• What determines the inflation rate
• What determines the value of the
Australian dollar
• Whether government intervention can
reduce the severity of an economic
contraction
• What are the labour market outcomes for
Indigenous and non-Indigenous peoples
18
 Microeconomics and
Macroeconomics
Issues in microeconomics and macroeconomics
Examples of Microeconomic Issues
• How consumers react to changes in product
prices
• How firms decide what prices to charge for the
products they sell
• Which government policy would most efficiently
improve labour market outcomes for indigenous
youth
• What the costs and benefits of approving the
sale of a new prescription drug are
• What the most efficient way to reduce air
pollution is
Examples of Macroeconomic Issues
• Why economies experience periods of
contraction and increasing unemployment
• Why, over the long run, some economies have
grown much faster than others
• What determines the inflation rate
• What determines the value of the Australian
dollar
• Whether government intervention can reduce
the severity of an economic contraction
19
Models in Economics
▸ Decide on the assumptions of the model, to create a SIMPLIFIED
description of reality
▸ Create a model under those assumptions
▸ Often using maths or diagrams to describe relationships
▸ Use that model to make predictions or to generate hypotheses
▸ Test the model using data

20
Assumptions
▸ Assumptions are SUPER important
▸ They should be driven by data, and by a theoretical understanding of how
they affect the model
▸ Assumptions that are demonstrably false may be appropriate in some
models
▸ It is important to understand if they may have driven the result
▸ Assumptions should be different depending on the context and questions
under investigation
21
A map is a ‘model’ of the real world
Assumption: Earth is flat(?!)

22
Rationality

23
Three key economic
ideas
1. People are rational.
2. People respond to economic incentives.
3. Optimal decisions are made at the margin.
▹ Marginal analysis: Analysis that involves comparing marginal
benefits and marginal costs.

24
Opportunity Cost

Definition:
The highest-valued alternative that must be
given up to engage in an activity.

25
If you have a free movie ticket, is
there is cost to going?

26
Does owning a building instead of
renting it make it ‘free’?

27
Attending this lecture
Suppose your top three things (in order) you could do now:
1. Attend the lecture
2. Go out for a coffee
3. Watch Netflix at home

What is the opportunity cost of attending this lecture?

28
Another example
Three ways you could spend your evening:
1. Stay home and study all night
2. Go dancing with your friends and eat pizza
3. Do the grocery shopping

The opportunity cost is the single top alternative forgone.

But the alternative CAN be a bundle of things.
29
Marginal Analysis
▸ Rather than comparing the total benefit and total
cost, we should always compare the marginal
benefit and marginal cost

▸ Marginal here means ‘extra’ or ‘additional’ benefit

or cost

30
Pizza Example
Slices of Pizza Total Benefit Total Cost Marginal Benefit Marginal Cost
1 $10 $4 $10 $4
2 $18 $8 $8 $4
3 $24 $12 $6 $4
4 $28 $16 $4 $4
5 $30 $20 $2 $4

A slice of pizza is $4.

Should you consume 5 slices of pizza?

31
MB=MC
Often we are looking at choices about continuous variables.
For example:
What price should I set for my product?
What quantity should I produce?

In many cases Marginal Benefit is decreasing, while MC is increasing

(or constant).
In these cases, choosing to increase so long as the MB is larger than
the MC, will result in the optimal choice being where MB=MC
32
Economics 101
▸ Us ▸ Them

33
Microeconomics and
Macroeconomics

34
Normative and
Positive Analysis
▸ Positive analysis: Analysis concerned with what is, involving value-
free statements that can be checked by using the facts.

▸ Normative analysis: Analysis concerned with what ought to be,

involving value judgements which cannot be tested.

35
Chapter 1 Appendix
▸ We will not be covering this in class specifically, but please look over it
to make sure you are familiar with the concepts included.
▸ Especially worth looking at if you lack experience with mathematical or
quantitative fields (or maybe it has been decades since you were asked to
calculate a percentage change, or the area of a triangle!)
▸ Generally this course will not be highly mathematical, but we will use
some of the above that are perhaps early high school level maths.

36
Production
Possibility
Frontier (PPF)
A curve showing the maximum
attainable combinations of two
products that may be produced with
available resources.

37
Tesla’s Production
Choices
Quantity of Quantity of
Choice Sedans SUVs
Produced Produced

A 80 0

B 60 40

C 40 50

D 20 57

E 0 60

38
39
Increasing Marginal
Opportunity Costs
▸ The bowed-out shape of the production possibility frontier illustrates
the concept of increasing marginal opportunity costs.
▸ Increasing marginal opportunity costs demonstrates an important
economic concept:
The more resources already devoted to an activity, the smaller the
payoff to devoting additional resources to that activity.

40
Increasing Marginal
Opportunity Costs

41
Increasing Marginal
Opportunity Costs
▸ The more wheat being produced, the more
wool that has to be given up per unit increase
in wheat.
▸ But why?

▸ Not all resources are equally productive in all

activities

42
Shifting the PPF

43
Comparative and Absolute
Advantage
▸ You are running a business building flat-packed furniture
▸ Two workers: You and your friend
▸ Two tasks: Building tables, building chairs
▸ How long it takes each of you to complete the tasks is shown below
Build one table Build one chair
You 20mins 30mins
Your friend 10mins 5mins

44
Per Hour
How long it takes to you to do things:

Build one table Build one chair

You 20mins 30mins
Your friend 10mins 5mins

What you can do of each in one hour:

Tables per hour Chairs per hour

You 3 2
Your friend 6 12

45
Absolute Advantage
The ability of an individual, firm or country to produce more of a good
or service than other producers using the same amount of resources

Tables per hour Chairs per hour

You 3 2
Your friend 6 12

Build one table Build one chair

You 20mins 30mins
Your friend 10mins 5mins
So who has absolute advantage in making tables? Chairs?

46
Opportunity Costs Tables per hour Chairs per hour
You 3 2
Your friend 6 12

We can calculate your opportunity cost of building tables in terms of the chairs you
could have built in that same time.
Your opportunity cost of building a table =
= (number chairs not built) divided by (number of tables built)
= 2/3 chairs per table
= 0.67 chairs per table
Build one table Build one chair
You 20mins 30mins
Your friends 10mins 5mins
47
Opportunity Costs
What you can produce:
Tables per hour Chairs per hour
You 3 2
Your friend 6 12

Opportunity costs:
Opportunity cost of tables Opportunity cost of chairs
You 2/3 = 0.67 chairs per table 3/2 = 1.5 tables per chair
Your friend 12/6 = 2 chairs per table 6/12 = 0.5 tables per chair

48
Comparative Advantage
The ability of an individual, firm or country to produce a good or
service at a lower opportunity cost than other producers
Opportunity cost of tables Opportunity cost of chairs
You 2/3 = 0.67 chairs per table 3/2 = 1.5 tables per chair
Your friend 12/6 = 2 chairs per table 6/12 = 0.5 tables per chair

Your friend has comparative advantage in producing chairs.

YOU have comparative advantage in producing tables.
49
A similar example
Turnips/Carrots in one hour:
Turnips per hour Carrots per hour
You 3 2
Your friend 6 12

Turnips/Carrots in four hours:

Turnips Carrots
You 12 8
Your friend 24 48

50
PPFs
Four hours working alone
You: Your friend:
Turnips Carrots Turnips Carrots

0 8 0 48

3 6 6 36

6 4 12 24

9 2 18 12

12 0 24 0

51
Opportunity Costs and
Comparative Advantage
Turnips per hour Carrots per hour
You 3 2
Your friend 6 12

Opportunity cost of turnips Opportunity cost of carrots

You 2/3 = 0.67 carrots per turnip 3/2 = 1.5 turnips per carrot
Your friend 12/6 = 2 carrots per turnip 6/12 = 0.5 turnips per carrot

52
Specialization and
gains from trade
▸ If each producers specializes in the task in which they have comparative
advantage, then we can have gains from trade
▸ You have comparative advantage in producing turnips
▸ Your friend has comparative advantage in producing carrots
▸ You can BOTH gain from trading, even though you are literally worse
at everything (your friend has absolute advantage in producing both)

53
Trade
You: Friend:
Turnips Carrots Turnips Carrots

0 8 0 48

3 6 6 36

6 4 12 24

9 2 18 12

12 0 24 0

No trade:
You consume 3 turnips and 6 carrots, your friend consumes 6 turnips and 36 carrots.

One possible trade:

You only produce turnips (12). Your friend only produces carrots (48).
You offer to trade 8 turnips to your friend in return for 8 carrots.
Now you get 4 turnips and 8 carrots, your friend has 8 turnips and 40 carrots. Both of you are better off!!

54
The point of that example
▸ The basis for trade is comparative advantage, not absolute
advantage.

▸ Individuals, firms, or countries are better off if they specialise in

producing goods and services for which they have a comparative
advantage and obtain other desirable goods and services by
trading.

55
The market system
▸ Market: A group of buyers and sellers of a good or service and the
institution or arrangement by which they come together to trade.
▸ Product markets: Markets for goods (such as computers) and services
(such as medical treatment).
▸ Factor markets: Markets for the factors of production, such as labour,
capital, natural resources, and entrepreneurial ability.
▸ Factors of production: Labour, capital, natural resources and
entrepreneurial ability used to produce to good and services.

56
The Free Market
▸ Free market: A market with few government restrictions on how
a good or service can be produced or sold, or on how a factor of
production can be employed.
▸ Adam Smith argued the benefits of a free market system in his
famous book:
▸ An Inquiry into the Nature and Causes of the Wealth of
Nations (published in 1776).

57
The Free Market
▸ Smith assumed individuals act in a rational, self-interested way.
▸ If not restricted by government, then firms would be led by the
invisible hand of the market to provide consumers with what they
wanted.
▸ Price mechanism: The system in the free market where price changes
lead to producers changing production in accordance with the level of
consumer demand.

58
The role of the entrepreneur
▸ Entrepreneur: Someone who operates a business, bringing
together the factors of production – labour, capital and natural
resources - to produce goods and services.
▸ Entrepreneurs are central to the working of the market system.
▸ They risk their own funds to start businesses, and often invent
new and important products.

59
Key Learning Outcomes
▸ This is not an exhaustive list of what you need to know. All content in
the textbook chapters, the lectures, the practice exercises and the
assignments is relevant and potentially assessable. This list is designed
to give you more idea on what topics and specific competencies to
focus your attention towards in your studies and in particular your
exam revision.

60
Key Learning Outcomes
▸ Explain the definition of ‘opportunity cost’, and apply it to potential scenarios
▸ Explain the definition of ‘marginal analysis’, and apply it to potential scenarios
▸ Interpret a provided Production Possibility Frontier (PPF), and use it to discuss feasibility and
efficiency
▸ Draw a PPF based on provided data points or scenario description
▸ Explain the relationship between a PPF and opportunity cost
▸ Explain why a PPF often has its ‘usual’ shape
▸ Understand what factors might shift a PPF in various ways
▸ Calculate opportunity costs from an example (such as producing two goods)
▸ Apply the concepts of comparative advantage and absolute advantage
▸ Explain the importance of comparative advantage to gains from trade
▸ Explain the basic idea of how a market system works. 61